For Certain Is Debt for the Born

September 8, 2010

Is the United States on a certain path toward a debt crisis? And if so, at what point will it strike? Economists disagree on the details, but the best answers we have to these questions right now are: "It sure looks that way" and "sooner or later...probably." In a recent paper, the Mercatus Center's Arnold Kling attempts to describe just how uncertain the workings of debt markets -- sovereign and otherwise --actually are, says Reason Magazine.

The trigger point for a debt crisis is not quantifiable. This is often true even in the case of private debt, such as a credit card balance. What should be the trigger point at which your bank disallows use of your credit card? The fact that different people may respond differently under similar circumstances poses an analytical challenge for the bank, says Reason.

Kling admits up front that there's no way to preemptively pinpoint the exact trigger point for a debt crisis.

But after laying out a number of the important factors, he concludes that if one accepts the Congressional Budget Office's (CBO) alternative fiscal scenario as the most likely fiscal path going forward, the United States will likely experience a debt crisis within the next two decades.

No surprises there; the CBO has described the country's fiscal path as unsustainable, Moody's recently cautioned that the U.S. has inched closer to losing its platinum credit rating, and earlier this year the International Monetary Fund told the United States that it needed to generate a "credible, medium-term" plan for bringing down its debt level.

Yet despite the warnings, Kling notes that "international capital markets continue to treat U.S. Treasury debt as a fairly safe asset." Why? In his paper, Kling suggests that it may be that "investors expect the United States to take steps to get its fiscal house in order," an assumption, he says, that is "based more on hope than on recent experience." Given the political disincentives to making the sort of policy moves necessary to stabilize our debt, it's not the safest assumption, says Reason.